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ComfortDelgro (CDG) is a Singapore private transport company with a wide geographical foot print. It provides a long term average earnings yield of 6.22%. Currently, its historical dividend yield is 5%.
CDG has been in the news due to increased competition from disruptive ride sharing companies such as Uber and Grab. These companies have large capital backing, was able to provide a lot of incentives for taxi drivers to switch over to driving private cars to pick up passengers instead of the traditional taxi.
As such, the market took down CDG’s stock price. When I started researching into CDG it was at $2.50. Many say it was cheap for a business of this profile. Then it dropped to $2.30. People say its cheaper.
There are a lot of voices that say CDG is done for.
At the time of writing the share price is $2.04.
Its been sometime since I worked my thinking muscle, after 1.5 years of my own “disruptions”, so I thought why not take a neutral view and see what this business is about. So that I can work some muscle. If you don’t work it, you lose it. I almost abandon it as I was not invested but realize some folks I know are invested and have a rather large position in it.
The summary is that at this price, I think we have priced in much downside in a conservative way. It is fair. Many are clamoring for a return to the $2.60 hey days. A lot will depend on how you see this black box that is CDG going forward. Your view of this box can be very different from me. However, it does seem that if the discount rate is 7.5% and with the same growth rate as in the past of 3%/yr, $2.60 is not impossible.
From here on is the 8900 words expanded version.
ComfortDelgro Group is a Diversified Transport Business
CDG is not only a taxi company. It is essentially a diversified business that deals with public and private transportation and support services.
The table above shows the amount of services that CDG deals with, and when they started in various countries.
They have not been expanding to new segments of the business. A lot of the business have been around in 2004, in the same geographical location.
If we were to name one foray that happened during this period we profile , it has to be their push into developed nation Australia in 2005.
With so much talk on the taxi business, taxi business account for 36% odds of CDG’s EBIT. The big contributors is still taxi and bus with rail being the third contributor.
The significance of this is that if you believe CDG is going to lose their taxi business, it is akin to a 36% fall in EBIT. It is big but you can see from a high level, the diversified business streams is actually a quality situation.
We could talk about a 50% reduction in EBIT from taxi here, and it is a 18% impact to last earnings.
If we know that, we can adjust the free cash flow and earnings accordingly.
The figure above shows the break down of CDG’s EBIT by country. Note that the taxi segment accounted for 27% of the 60% Singapore region.
What made up the other 9% of Taxi that is not in Singapore? Based on the narrative, this would be China.
This further changes the picture that, if CDG’s Singapore taxi business is wiped out, CDG will see a 27% plunge in earnings here.
If we are not expecting such a drastic fall in business but a 50% one, we will see a 14% impact.
Again the situation might not be as bad.
The caveat here is: Is China’s Taxi situation is in a similar state?
If it is, and it is a sector secular shift, then we need to priced in more profit reduction accordingly.
China’s country analysis will be carried out further below.
Return on Asset of Various Business Segments
Gaining an appreciation of the return of assets of the various transport services segment allows us to know how lucrative the business is.
Return on assets gives us an idea of the leveraged return over time.
It also allows us to measure up against the cost of debt of around 4% and cost of equity of around 8-12%.
To manage your expectations, in the past in the 2000s, infrastructure assets such as properties, utilities, toll roads that are not leveraged would yield around 6%.
The public transport service in Singapore is made up of rail, bus and taxi.
In the early days in 2004 to 2005, Singapore was able to garnered above 14% ROA. Since then, the ROA have went down to a stable 8%.
Much of the reason can be attributed to the increase in capital expenditure required for the bus service and earnings not being able to scale accordingly.
The taxi margins have been stable. The average ROA for taxi over the 13 years is 11.6%.
The table above shows the ROA based on country.
Singapore is a combination of majority in Rail, Bus and Taxi as well ass Vehicle Inspection and Engineering. Its got a very good ROA on an average of 13.50%.
China is predominately Taxi. The ROA have improved over time from 10% to 14%. The average of 12% is quite close to CDG average ROA of 11.6% for Taxi.
UK/Ireland is predominately bus contracting. The ROA is damn good at 17.6%, primarily due to the asset light model.
Australia is also in bus contracting but their average ROA is lower at 7.7%.
Vietnam is in the business of taxi and they average a 7.7% ROA.
Malaysia is in the rental and leasing of car business. Its average margin is 10.7%. This is lower than the taxi business but pretty comparable.
This segment used to be separate as rail and bus.
A Primer to the Rail Business
In 2003, SBS Transit, a 75% own subsidiary of ComfortDelgro started operating the north east line (NEL). Since 2004, CDG have added bus services overseas through expansion and acquisition.
They have also take on the Seng Kang Punggol LRT and the downtown line (DTL). DTL is broken up into 3 phases which the last phase suppose to go online later this year.
- NEL Operation since 2003
- DTL Phase 1 December 2013
- DTL Phase 2 December 2015
The way the rail operations work is different for each line due to the contractual terms define at inception. NEL is under the old framework.
While they do not own the assets, they bear the cost of maintenance capital expenditure. They also earn the revenue of what they earn. This means that if there are greater ridership, they earn more revenue.
Since they bear the cost of maintenance capex, this pose a big problem in that with the recent deficiency we see in our rail network, greater capex is needed, and this cost is borne by SBS.
This is different for the DTL which is under the license model. Under the license model, SBS will be responsible for the maintenance while the assets are owned by Land Transport Authority (LTA).
If there is a need for capex, this is funded by LTA.
In all models, the staff and fuel costs are borne by the operator.
For NEL and DTL, the revenue is still from fares and ridership. So it is dependent on regulation of prices and population growth, not to mention the urban development of Singapore.
For DTL is a bit murky, in that it is the NRFF model. This likely means they earn someone close to a 5% operating margin, but they bare the revenue risk. I wonder how that works out. Evidence of this is that DTL is operating right now and currently facing losses. If they are earning a true fee based model, shouldn’t they be not having losses? The only explanation is that it has higher start up cost, where the return will come in later in the contract.
In initial stage there will be losses, but as ridership increases, the profit will take off as most of the investments are in fixed investments, so the rail business enjoys the operating leverage (refer to the NEL snapshot below)
A Primer to the Bus Business
CDG operates a fleet of 3,448 buses under SBS in Singapore. They also operate bus network overseas.
In the local context, SBS is able to earn the revenue it collects from fare prices (fare prices are controlled by authority). They also bear the costs and capex.
The operating profit used to be great in the past, until huge capex starts making bus owning look mediocre (we will see this later)
In May 2014, LTA announced a change in model to the GCM model.
Under GCM Model, the bus operators will operated on a cost-plus contract.
Basically, the operators will earn an operating margin (which is unknown as of this year, possibly between 5%-10%) and performance fee.
This model is better for the bus operators because it allows them to focus on providing services.
The revenue and capex risks will be borne by LTA. This means that should the fare prices increase, SBS do not earn extra. If we require 1000 more buses, SBS does not bear that risk. They are still subject to operational costs (but indexed to inflation)
Out of the 12 bus contracts, 3 are given out for tender and the other 9 is operated by SMRT and SBS. The tenure of each contracts differs.
This model shift is significant.
The table above let us compare 13 years of capex requirements between CDG’s public transport service and taxi segments. For simplicity, trust me that the capex for the public transport service, majority belongs to the buses and not the rail (since rail’s capex does not jack up like that and operating in a license model)
Capex – Dep shows the excess that CDG/SBS invested in the segment on top of its depreciation. A higher number shows more investment then depreciation.
The public transportation service shows after 2004, there is a consistent excess investment.
While we do see excess investment in Taxi, there are some years where it tapered off, and some years where its higher (04,05,15,16).
This extra cost is evident if you look at the bus EBIT Margins over time.
Here are the details of the future GCM packages:
Note that the number of operating years are also different!
A Look at the Financials of Public Transport Segment
The table above summarizes 13 years of segmental data of the public transport service. This is made up of CDG’s bus, and rail business in Singapore and in other countries.
We have a good sense of the growth of this segment.
The revenue grew at 5.7%/yr for the past 13 years.
The operating profit grew at 4.9%/yr for the past 13 years.
If you are looking for some baseline growth rate this is some figures to get started.
Revenue have been increasing every year, except the period of 2008-2009 by way of organic and acquisitions.
In the past 13 years, net of depreciation, CDG have put in $1,750 mil in net investment. This is pretty close to the difference in assets value during the period ($1,655 mil). This is an average of $134 mil a year.
The main attribution of this is perhaps less of overseas acquisitions but large capital expenditure by SBS. If someone mentions to you that these transport company are earning good money from you, this may not be the case.
The operating profit margins decline but it was a slow decline from 8.4% to 7.7%. This should be a blended margin between the high of 15-17% for the rail business and the lower margins of 5-7% for the bus business.
The return on assets (ROA) was damn good in the past (2004-2007) which was above 10%. What is not reflected in the data is that, for the year 2004, the bus division have an ROA of 19%!
This is even more remarkable considering that from 2004 to 2005, the rail business have been making losses (refer to the NEL snapshot below).
Since then ROA have come down to 8%.
In my opinion, this ROA at 8% is pretty good, as during the times when risk free rate is higher, infrastructure assets, utilities that are unlever earns an average ROA of 5-6%.
To me this was an above average business.
Snapshot of NEL Profitability
The rail business for a long time for SBS and CDG is based on NEL. They been operating it since 2003.
It starts of bleeding and eventually becomes more profitable as business picks up.
In the midst of this, it went through a period where inflation is so called “higher”
There is also a period of higher oil prices which means higher fuel charges.
Here is its profit change
- 2003: -33 mil
- 2004: -17.3 mil
- 2005: -6.3 mil
- 2006: 0.6 mil
- 2007: 9.3 mil
- 2008: 16.7 mil
- 2009: 20.5 mil
- 2010: 25.6 mil
- 2011: 27.7 mil
- 2012: 14.3 mil
- 2013: 4.8 mil
- 2014: 7.6 mil
- 2015: 3.2 mil
- 2016: no more rail data (combined into public transport services)
The dip in profit from 2011 to 2012 is likely due to the start up cost for DTL 1 which commence operation in 2013.
I would say in the face of inflation and high oil prices, they do pretty well.
If we take a look at 2011, where the NEL profitability is easily shown as the highest, the overall public transport profit is $172 mil.
NEL makes up 16% of the overall profit.
NEL took like 3-4 years to reach from negative to positive profitability.
Over time, we have to consider that some of the ridership of NEL is likely to be dissipated as more rail lines come into the picture. (profit for NEL still based on fares and ridership)
This means that profit growth will moderate down.
In a 2016 report, Nomura hold the same view, but they also helped me calibrate some of the operating margin expectations.
In a Sep 2016 UOB Kay Hian report on the configuration of potential move of NEL to a NRFF like contract model, they highlighted the historical profit margin of SMRT. It looks damn delicious.
Downtown Line (DTL) Profitability
Revisiting the rail profitability figures:
- 2011: 27.7 mil
- 2012: 14.3 mil
- 2013: 4.8 mil
- 2014: 7.6 mil
- 2015: 3.2 mil
DTL 1 started operations in 2013 but likely the business started accounting for losses in 2012. There is profitability recovery in 2014.
DTL 2 commerce operations in 2015 so i would assume from the figures they started accounting the costs in 2015.
CDG have given guidance that DTL 2 should break even by the time DTL 3 commence operation, which gives it around 2 years to be positive
While we cannot see the rail profit figures from 2016 onwards (WTF CDG), I do expect 2016 to show a dip in profitability due to DTL 3 and then a similar low figure in 2017 before a 2-5 mil profit growth in 2018.
This will not make a big different to the $178 operating profit of the public transport service in 2016 (estimate to be a 2.9% growth)
Will DTL as a whole, have significant growth as NEL?
It is likely not as the DTL, under the NRFF, will see CDG getting more moderate income growth.
Estimating the Cash Flow of the Local Bus Business
Based on the cost plus contract model, it is likely the profitability of the local bus business is driven by the contract value and the operating margins.
The operating margins will depend on the amount of staff and other operation cost they hire. A certain part of the costs are linked to inflation.
It is a question of how much operating margins that can be earned.
If Tower Transit and Go Ahead is coming in to compete, you expect them to have a certain expectation how much they can earn.
If the cash flow and margins is not there, why spend so much effort to come in and compete?
However, as I have said, the government will not give great operating margins.
My suspect is closer to 6-7%.
This is the margins that the foreign operators are looking to earn.
Based on Macquarie research the contract fee per package is about $92 mil.
The contract length is different, but on average they are about 7.25 years.
So the per year contract fee can be 7.25 x 92 = $667 mil.
Here is the operating profit, based on different profit margin sensitivity:
- 5%: $33.35 mil
- 6%: $40.02 mil
- 7%: $46.70 mil
- 8%: $53.36 mil
- 9%: $60.03 mil
- 10%: $66.7 mil
Speculation of the Future Cash Flow in the Public Transport Segment
To speculate on the future, we need to understand the past.
SBS’s result is a mixture of
- relatively medium term (bus) and long term (rail) operating contracts
- overseas contract likely based on cost plus contracts with a certain operating margins that can be earned
- NEL that is operating below baseline ridership, that started off at losses before become profitable
- 2 phases of DTL that is operating below baseline, and is still not profitable (DTL phase 1 have become positive)
- A move from normal operation for Singapore bus service to the government contracting model that is capital expenditure light but only earning a possible operating profit margin between 5%-9%
The attractiveness of this segment is that this is a business segment that is not going away. The government need providers to operate these service and regulated in some ways.
Even with autonomous vehicles, the business model will shift but likely be around in some ways.
New ways will sought to disrupt but likely augment or replace particular segment of the business. The decline will reach a terminal stage in some ways.
These contracts are a service to the people, and there is a regulation and cap on the growth rate.
Fare prices are capped and cannot increase. However do note, this is in the past.
In the future, their NEL business profitability will still be based on how they manage costs and how much ridership. So is the DTL.
However, the bus segment under GCM is based on earning an operating margin and so are the overseas investments. In the future, if they win rail lines such as TEL, it will be under the NRFF model, which is also based on a operating margin.
This means that the future is asset light, but earning an operating margin. The public is not going to be happy to learn SBS or their local bus and rail company earning a above 10% operating margin. So there is a limit there.
The advantage is that the government can set fares at $0.10 per trip and the rail and bus business will not drop into huge losses because they earn a fixed revenue fee for it (except for current NEL and DTL). They do not borne capex costs (except probably for NEL)
The rail business, only NEL is profitable but not DTL. DTL will eventually reach there. The revenue is dependent on fares, but also dependent on population growth in Singapore. The profitability will depend on cost control.
The new GCM contract is between 5-7 years and it is not a given SBS can win them in the past, so if they do not win, less business, less profitability.
However the rail contract still have 46 years and 15 years to run. (this is like a long real estate tenant lease)
Do note, the operating margin is based on a particular contract value and NOT based on current ridership and fare revenue. This means that estimating based on the data above can reach drastically bad outcomes.
You can only get a better handle in the next year when GCM operates for a year (capex is likely going to be much lower, revenue level will change). We will then find the true operating margin.
The operating margin of public transport is a pull between NEL and DTL improving (better) and bus business model improving (better) but lower operating margins (worse). If they fail to provide satisfactory service (locally or overseas) they would lose the contracts (worse). If they win additional contracts such as the TEL, they get to earn a possible 5% operating margin.
The net effect is the downside profitability risk is drastically reduced for CDG.
But you might not get the great growth rate. Growth rate is likely to be organically 2-3%/yr + investments overseas at 8% ROA x % of retained earnings that is not paid out.
Certainly, in the next 2-3 years, GCM will see better profitability but this will offset the losses in DTL, thus the growth will work out better after this 2-3 years.
SBS Transit Did Not Win the Thomson East Coast Line
The upcoming Thomson East Coast Line (TEL) was won by rival SMRT.
This seem to be much anticipated by the analyst, and the share price did not react well to it. Shortly after the announcement, the share price fall on the next trading day.
I was surprised by the sell down not because they failed to win but that in recent analyst reports written, the TEL line wasn’t mentioned in a big way.
Despite that, the bus business of SBS Transit with the GCM model will be more volatile and shorter in duration. This is not good for SBS and CDG.
The better revenue contract is the rail contracts.
Even if CDG Won TEL, it doesn’t Guarantee Exceptional Profits
From what we see so far of how the DTL is panning out, missing out on TEL operation might not be that big of a disaster.
Many investors were still expecting the kind of profit figures of NEL. However, we have to remember that DTL runs a different contract.
I expect that the break even period to be faster, but there will be a cap on operating margins.
The contract should not be far off from the kind of contract for SMRT’s NSRFF. After all, why is there a need for different contract standards.
The focus on these contracts looks to be to tie operators to service level agreements.
Due to the political heat of the transport issue, it is likely that the contract allows the operators to be profitable, but won’t be so profitable that it draws critique from the public.
Future Contracts Might not Be Lucrative
The bidding of TEL also put some questions into how profitable the future contracts will be.
Daiwa’s analysts highlight that CDG lost out on the TEL as the competitors SMRT priced their bids 30% below theirs.
SMRT have been nationalized and thus profitability is not the main aim here.
This is a challenging competitor to bid against because if profitability is not the main driver, and there is little focus on the operator’s ability to deliver a good service, even if you get the contract, it means you will do a lot of work for inadequate margins.
Other than Rail and Bus segment, the Taxi Segment is a major profit contributor.
And this is the segment that is currently facing a challenging situation.
The taxi business is predominately made up of Singapore and China.
Taxi business makes up 36% of CDG’s EBIT. Out of this, China makes up 25% of this, while 75% belongs to Singapore.
Nature of Business
The nature of the taxi business is similar to property management.
A taxi company purchases vehicles on the market. Then they attract prospective customers (who are the taxi drivers) to lease the taxi from them at a particular daily rate. Different taxi companies may have different payment schemes. Some have a monthly salary instead of rental provided the taxi driver satisfy a particular amount of trips per month.
There are allowances and incentives to attract taxi drivers to continue to lease from them.
There is a very strong network effect in this business.
As a consumer looking for taxi during peak hours, I would try to book a cab from the company that I have the greatest chance of getting a taxi. This will be the largest network.
As a client of the taxi company (the taxi driver), I will go with the taxi company that can reach the largest pool of customers.
Taxi drivers need to apply for a Taxi driver vocation license (TDVL) in order to be a taxi driver. The taxi drivers used to need to clock 250km per day. This is to prevent clients from renting the taxi but not using it for the purpose of taxi.
Taxi’s are given the right to take passengers who flagged off on the side of the road and also enter places where taxi are the official pick up points. Private cars were not allowed.
The taxi company also provide the client with intangible and tangible benefits.
The biggest being able to take bookings from consumers who called in to book cabs.
Each taxi purchased is leased to a taxi driver for 8 years and depreciate accordingly.
The taxi company is just like a financing company. A client do not have the capacity to purchase a vehicle for business. So the taxi company does it for him.
The client then pays a rental fee, which includes the interest payment, principal repayment and residual profits for the value the taxi company provides. The Return on Asset is impressive.
The rental rate increased if demand for taxi outstrips supply. If supply outstrips demand the rental rate falls. There are also inflationary element to the rental rate.
The margin gets cut if the vehicle cost is more expensive. This means a larger portion of the rental goes towards depreciation.
The table below shows the 13 year historical figures for the taxi portion of the business. This should be a combined of local and overseas.
In short revenue for taxi division is very good over the 13 years. You do not see the kind of weakness like the other division. Taxi rental looks to be good business.
In terms of profitability there is a dip from $160 mil to $105 mil in 2009.
We can appreciate the results better if we include a snapshot of China’s profit contribution. China have a increase in profits from 2005 to 2008, follow by a gradual stabilization of profit contribution of 45 mil.
In 2008 almost 55% of the contribution seem to come from China. Today it is closer to 27%.
CDG’s success in China contrast against the drop in profits from 2004 to 2008. The poor profit performance very much could be attributed to the Singapore situation.
The Singapore local taxi scene in the past 10 years have been strong. The most recent dip? NOW.
Prior to that, the dip was during 2004 to 2009. Let us look at some other metrics.
Changes in Local Taxi Supply – Competition is not Good
CDG, with Comfort and CityCab have been the dominant taxi operator in Singapore.
While CityCab have shown weakness from 2005 to 2010, Comfort have shown a gradual growth, with the occasional spike in number of taxi.
In recent times, we have seen a fall off in the number of taxis for Comfort and CityCab. Both taxis dip to the 2011 levels.
In 2003, there was a proliferation of new private taxi operators.
We see many companies jump into the fray. SMRT, Transcab, Smart and Premier were the new entrants. This coincide with the drop off in CDG’s taxi profitability we observe from 2004 to 2008 results.
CityCab lost about 1000 cab by 2008 while Comfort gain 1000 cab.
In this period, Transcab added 2000, SMRT 3000, Premier 2000.
The competition from private hires did not affect Prime, Premier much but SMRT and Transcab was also affected as CDG.
Here is a more microscopic look at the number of taxis from each company from Jun 2016.
Competition in an environment where the demand and supply is matured will shrink the pie. It also constrains the taxi daily rental rate for each company.
While fleet was still increasing for CDG from 2004 to 2009, profitability was not rising.
If profitability is mainly determined by the amount of vehicles rented out, then CDG’s profitability should be much better in 2004 to 2009.
How Private Ride Sharing Companies GRAB and Uber changed the Landscape
Private ride sharing companies have been disrupting traditional taxi business in a very big way.
Removal of Exclusivity. Taxi Companies have always have the exclusivity to gain access to people looking for premium transportation through their call service, taxi stand and ability to take passengers flagging off. With an application that is on everyone’s phones and people familiar with getting cab this way, that exclusivity is gone.
Removal of the network effect. CDG’s strength is that they have a lot of taxi and thus consumers will naturally think about them first. What Uber and Grab did was to create a consumer taxi driver matching system independent of taxi company. This remove a big advantage of CDG. Their competitive edge was tore down overnight.
Increase the Supply. The application of Uber and Grab have allowed private cars to be able to moonlight and pick up passengers. This increased the supply of taxi like service.
Increase competition for drivers through incentives and flexibility. To build up the network of taxi drivers and consumers, Uber and Grab have been providing incentives for both sides to use their service. Because they do not need to answer to their shareholders by providing payments in the form of share price rises and dividends for the time being, they can greatly increase the incentives to disrupt CDG.
This affects the expenses of CDG and in turn affects their margins.
Oversupply of Vehicles have pushed Rental Rates Down
The government have mandated that those drivers who would like to operate for ride sharing would need to apply for a Private Hire Car Driver Vocational License (PDVL)
There is a cost to this, not to mention time spent securing this license.
This reduce the number of people applying for PDVL. When demand reduced, there are more cars that less eligible people can drive.
This becomes a free for all fight for eligible drivers.
Macquarie reckons that there are lot of shortage of eligible drivers fighting for cars that needed to be leased out.
Competition increases Costs
And this means CDG’s margins for taxi segment will go down.
The maintenance of the corporate overheads, the book system and other incentives work better when there are economies of scale.
These things are fixed costs, while the vehicles, to me are variable.
If you increase from 11,000 vehicles to 15,000 vehicles, the costs do not scale up proportionately. The gross profit go straight to the net profit.
In the opposite scenario, cost for CDG do not scale down proportionately as well.
To make matters worst, CDG have to increase their marketing expenses to be competitive.
Uber and Grab have breached the vast gap to tear down the traditional CDG’s network effect by using incentives.
They are front loaded with capital and deploying it as marketing expenses to acquire the network effect,
Look at it this way, CDG incur the fixed and variable costs, by owning the assets.
But Uber and Grab do have their costs. Because they are asset light, they incur larger than normal marketing expenses. That is their running capital.
The promotion above lets consumers take Grab without having to bother about the $2.xx booking fee. This promotion can take place from 3 days to 1 week.
In the past CDG do not need to provide incentives like this.
Now they have to come up with promotions like this. The cab drivers that I spoken to told me in recent weeks, there have been more efforts to provide consumers with incentive to book through comfort.
However, because they have fixed costs, they can’t go all the way.
The biggest incentives that CDG are unwilling to give is the incentives Uber and Grab gave to the drivers.
If a Grab or Uber driver makes a particular number of trips, they get to earn these incentives. These incentives does change.
For reference, the average daily number of trips made by Taxi drivers (not Grab or Uber) is 17.7. In a 7 day week period, they would have made 119 trips and earn 225 in the above.
But I suspect people will aim for the $450, which forces them to make 25 trips per day.
This driving incentives, according to what I read up, makes up 25% of the Grab drivers earnings.
If this incentive goes away, you will wonder if the Grab drivers will stick with Grab.
It is Easier for a Prospective Driver to get a Private Car Hiring License
Comparatively, getting a PDVL is easier than getting a Taxi one.
And in the above section, we can see that the total number of valid TDVL holders looks to be going down.
This picture is rather grim if you look at how much number of TDVL was issued (2016 Jan to Dec) versus now (2017 Jan to Aug).
Given the choice, and lower rental, people might just settled for a license which is a lower hurdle.
This does not bode well for CDG.
Car Rental without Being a Taxi is Still a Rather High ROA Business
The overheads if CDG operate as a Taxi business is likely more than that of a traditional car leasing business.
CDG does have segmental on Car Rental and Leasing.
If you look at their ROA, it is above 10% unleveraged.
Compare this to the average Taxi ROA of 12%.
A car rental company purchases the car as most of us do through the same COE bidding process and all.
Suppose they secured a car for $110,000. This car depreciates over 10 years, thereafter you can redeem some value.
The car rental company rents out for $50-$65/day.
If fully utilized, or when we say no vacancy, and rented out for a year, this is $55 x 30 x 12 = $19,800. There are some overhead cost, spread out by the number of cars leased out.
The costs do not go up proportionately as the number of cars leased out.
Even if you factor in $833/mth depreciation, it is still very lucrative.
And CDG have been renting them out at above $100 so you can imagine how lucrative this is.
However, in recent cases more of these are in idle state, and this means higher vacancy.
CDG Could Drastically Cut Down on its Capital Expenditure
Analyst expect CDG to not have to spend capital expenditure in the future.
The 2016 Capital Expenditure on Taxi is $326 mil. In 2015 it is $339 mil.
That is almost worth CDG’s entire dividend.
However, we are losing operating cash flow due to lower Taxi rental rates, operating leverage working against them, and higher vacancy.
Net net all these might just balance out.
CDG’s Taxi Segment Revenue in 2016 is $1340 mil. About 75% of this revenue is attributable to Singapore Taxi.
If we assume a fall of 11% fleet, this equates to a loss of $110 mil. The forward revenue for Singapore Taxi could be $895 mil.
If we take a 27% cut in rental rate from $110/day to $80/day, CDG will lose a further $241 mil.
In total they might lose $351 mil.
Net Net, CDG might end up with the savings from capital expenditure cancelling out the loss in vacancy and slash in margins in this scenario. If part of the capital expenditure is attributable to their China ops, and capital expenditure cannot be cut, net net, CDG should be suffering some $100 mil in Singapore Taxi Losses.
Country Segmental Analysis
It might be beneficial to take a snapshot of CDG’s international business.
This may let us have a better understanding about the nature of the business.
The table above breaks down the type of business that CDG have investments in.
Initially, I thought that it is over the past years that CDG manage to spread their footprint all over the world.
Not so. Since 2003, they have been in China, UK, Ireland, Australia, Vietnam and Malaysia.
The core business in these countries stay the same.
For example, UK/Ireland have been mainly doing bus public transport with less in taxi. This is the same for Australia, which they entered in 2005 and only added on private taxi business via acquisitions in 2010.
China in contrast, have a high proportion in taxi business.
This makes our job easier as we can tag Australia and UK/Ireland to appreciate the overseas bus business and China as a proxy to appreciate the overseas taxi business.
In terms of profit, Singapore is still the main contributor at 60% of the operating profit. China’s Taxi, UK/Ireland and Australia buses are significant contributors to the profit. Their business in Vietnam and Malaysia is less significant.
CDG have expanded into China over the years. In my notes on its acquisitions, it has been replenishing its taxi fleet, acquiring more taxi licenses.
From 2005-2007 there are more investments into capital expenditures, since the capital expenditure have been reduced. We can see a more consistent S$25 mil maintenance rate.
Capex as a % of revenue also went down dramatically since early investments.
Given this, we have seen revenue rising to 2009 before going down.
I wanted to see if there are any currency effect that would cause this. Based on the RMB to SGD movement, there seem to be some effect.
From 2009 to 2011, RMB weaken against the SGD, the revenue seems to weaken during this period as well.
From 2011 to end 2015, RMB strengthened against the SGD, the revenue seems to have stabilized.
After 2015, RMB weaken again, which coincide with the drop off in revenue.
I would think we cannot attribute every revenue changes to currency movements. In recent times, the reports have indicate stiff competition from ride-share companies.
Given the revenue profile, it is somewhat surprising that after 2011, we do see some improvement or stabilization in operating profit. Capital expenditure since the early days have kept low (except in 2011) and the profit can grow despite the investment.
Initially, I do have the pre-conceived notion that a lot of the profit growth was due to business pumping in more money. Without money flowing in, there will be no growth.
This seems less of a case here.
Profit margin recovered after 2009 to a very healthy level. The margins is where we think greater private hires or competitive taxi companies could bring it down, but CDG’s China business seems to be doing very well, despite the recent narrative about the stiff competition over there.
Due to the reduction in capex over time, seems return on assets do show some improvement.
On an average, CDG’s China business have an average of 12.2% ROA.
Next to Singapore, CDG’s UK business have been its biggest contributor to the bottomline.
Of note is the acquisition of radio meter cabs in 2008 and the acquisition of First PLC Group’s West London Bus Operations.
In terms of Capex, the biggest jump was the 2013 acquisition. Excluding that, the capital expenditure have been very stable at around $50 mil. The capex to revenue ratio is very low averaging 6%.
CDG’s UK business have not been doing very well in terms of revenue. The acquisition of First PLC’s West London business did improve its top line but looks to be decreasing as well.
If we take a look at the currency changes over the past 10 years, we can see a correlation of revenue with currency changes. GBP have been on a consistent weakening trend against the Singapore dollar.
This seem to coincide with the revenue movement.
Given the revenue movement, the operating profit looks much controlled. While revenue fell from 2008 to 2012, the profit is quite consistent.
I believe the reason for the better bottom line was due to better cost controls. You can see here that since 2008, profit margin have improved tremendously.
Prior to the purchase of First PLC’s West London business the profit margin is 7%. Since then its even higher.
CDG’s UK Bus business comes with a great 17% average return on assets. And it seems the acquisition in 2003 improve CDG’s UK business in terms of quality versus its existing business.
Since 2005, CDG sought to build up their Australia business by way of numerous acquisitions.
The big one was the joint venture in 2005 to purchase New South Wales largest bus operator Westbus together with CabCharge, which owns 49% stake.
In 2016, CDG purchased the rest of the 49% stake of CabCharge in this joint venture..
Due to the acquisitions, the CDG Australia’s capital expenditure stayed high above S$100 mil from 2005 to 2012.
After that the amount of capital expenditure went down.
In terms of capital expenditure to revenue, we can’t see clearly from the chart as a large part of the capital expenditure before 2012 was above that of the revenue.
If we take a look at the actual figures, after 2011, the capital expenditure stabilized and started to declined. In the last 2 years, its capex to revenue is quite similar to that of CDG’s UK business.
As the capital expenditure taper off in 2012, the growth in revenue for the Australian business also tapered off.
The moderation in revenue also coincide with the weakening of the Australian Dollar from 2012 onwards till 2016.
In all 3 cases, currency weakness against SGD have been a consistent story.
In contrast to China and UK/Ireland, CDG Australia’s operating profit did not stabilized after the send of their acquisition spree in 2012. Perhaps cost control was not done very well.
CDG’s Australia over the past years have enjoyed much higher operating margins of greater than 10% to as high as 20% versus UK’s 7% operating margins.
I believe the difference is that CDG operated more private buses in Australia, which means a better margins.
The analysts are estimating between 5-10% operating margins for the Singapore GCM contracts so this is not so far off from CDG’s UK margins.
While operating margins look good, the return on assets look much worse than the China and UK business.
Indeed, UK business has a lower profit margin, higher revenue, lower assets while the Australia business have a higher profit margin, half the revenue and much higher assets.
The full purchase of CabCharge’s 49% stake in their Australia Joint Venture will result in some cash flow going back to the shareholders.
Capital Expenditure Summary
From the segmental look, we can see the business needs to replenish existing vehicles and also there are the occasional investment capital expenditure for new licences.
Over time, after the initial acquisition, capital expenditure was stabilized. This is evident in UK and China.
When it comes to acquisitions, there is no major capital outlay that their retain earnings cannot handle.
On average CDG retain 38% of its net profit from 2005-2017. Based on a profit of $300 mil, that amounts to $114 mil.
Major overseas capex includes:
- 2005 China: $111 mil
- 2006 China: $111 mil
- 2011 China: $90 mil
- 2013 UK: $166 mil
- 2005 Aust: $142 mil
- 2007 Aust: $121 mil
- 2009 Aust: $359 mil
- 2010 Aust: $117 mil
- 2012 Aust: $109 mil
- 2016 Aust: $196 mil
There can be concurrent overseas acquisitions, but it is viable for acquisition to take place out from retained earnings and not through leverage (which is an additional lever to pull)
Currency Devaluation a Constant Theme
The issue with venturing overseas is that you need to contend with currency fluctuation. From the revenue profiles versus the currency movement historically, there is strong correlation that currency have a big effect on 40% of CDG’s profits.
Return on Assets Summary
From the review of the segmentals, we have a greater appreciation of the kind of return on assets we get.
This can be used in the future for estimation of future acquisitions.
Singapore is split of 50% bus, 50% taxi, China is mainly taxi. Getting 12% ROA in the last 6 years is not unheard of.
Australia and UK are mainly buses. Australia in recent years have a 7% ROA while UK enjoy a whopping 17% ROA.
Malaysia’s car rental business enjoy 10% ROA.
Overall, the ROA for any of the business on average, equals that to the cost of capital of equities (1o%)
Compare this to properties where CAP Rates (net rental income / value of property) tends to be between 3.5% – 8%.
These look like good businesses.
A Guess of CDG’s Future Cash Flow Profile
CDG has a diversified stream of income and they could move in different direction.
I think this fact was lost in the narrative.
For the folks reading this article, they might lose that as well because not may would read until so deep in HA HA!
If I were to do a rough break down of CDG’s EBIT it will be something like the above. Singapore Taxi is a big component, but it is still near a quarter of the EBIT.
If we are to invest for a 10 year horizon, we should be reviewing CDG’s baseline over 10 years and not 2-3 years. There might be pain. But how would CDG look in 10 years time.
China Taxi figures looks sturdy but we are under no illusion that there might be some pressure. The baseline in the future is that it will be affected by currency movement and competition.
Australia and UK bus business are affected by currency and their profits can be volatile.
The Singapore Bus and Rail business should do OK. While not winning TEL is not good because the contract for rail is longer. I doubt TEL and Downtown line is under a contracting model that will be as lucrative than the NEL. And this might be missed by many.
The Bus GCM Model will return lots of cash flow from the government, but will go down to paying debts. This segment will be cash flow positive and SBS Transit will try to return as much of the cash flow to the parent CDG. Downtown line will likely still bleed for 1 year but the growth of it will be “controlled”.
I am of the view the government will not give a lucrative contract with high operating profit margin that the operator can earn from due to the fire that they would drew from the public. It is likely something that will be close to what SMRT got which is a 5% operating margin that is capped pretty well.
The inspection business will be around because while there may be less taxi, there is a controlled supply of vehicles. This is unless the secular direction is for public transport to be so efficient that the number of vehicles will go down. This scenario is possible but not likely in the near term base case.
The lucrative aspect could be that with private hires, government may mandate a semi annual test of vehicles, or an annual test. This might be lucrative for VICOM.
The outlook seems to be more grey for VICOM’s testing division, whether they could stem the rot, whether the oil and gas testing is in some form of longer term rot.
The Automotive & Engineering segment is made up of both Singapore and China. While they do many other repairs, it is mainly to serve the CDG taxi fleet. In the future they may have to venture out and do business with the rest. My guess is that they already did but gain less traction.
Finally, the Singapore Taxi segment is facing challenges. The number of taxi will be cut. And the margins will be shaved.
If we revisit the Taxi Segment ROA, you will realize despite the change in number of taxis rented out over time the ROA hovers around 9% to 12.6%. On the average it is 11.5%.
China, which predominately does the taxi business have an average ROA of 12% so its not much different.
We can try to be conservative and take it that the ROA becomes 8%.
In 2016, CDG has the following Taxi Fleet:
They have 16851 taxi.
We are coming near the end of the challenging year and the Taxi Fleet for CDG is as follows:
So that is 15127 taxi. We can see a clear down trend.
So lets be conservative and guess that the future baseline number of taxi they will have is 12,000 and they earn a 8% ROA.
We assume each taxi earns $1 and if we have 17,000, the revenue is $17,000. There is a step down of ROA from 12% to 8%. The net effect is a -53% shave in EBIT.
So what if the situation isn’t that bad that the baseline taxi fell to 13000?
The net effect is not much to be honest.
What if the ROA isn’t that bad but similar to the low of 2009 at 9%?
Ah there is a difference. The margins is more important! The eventual baseline will be more competitive hiring landscape.
That is the secular trend.
So let’s take all this add figure out the net EBIT change in the future.
We take it that due to the competitive landscape of the other country, and the currency fluctuations those would not change much. The other businesses are not affected.
The main change is the reduction in number of taxi and the impact to the automotive and engineering. This segment constitutes 38% of EBIT.
The net effect is a -17.35% impact on the bottom line.
However, what if, in the base case, the other segment does grow a respectable 3%?
The net effect is a 2% improvement. I suppose given 7 years of general country, market growth, CDG can get back to its current profitability.
So we have a -17% effect to profit growth to think about.
When we reach this point, we have worked out this black box that is CDG.
Now we try to look at the valuation.
CDG is a multi cash flow stream business and usually we will do a discounted cash flow of each segment than do a sum of parts to add them together. We will then deduct off the net debt (total debt minus cash).
Discounted Cash Flow
But…. because I am tired I will not do this at 4 am in the morning. So you can do this and tell me what you get.
So I will do a discounted cash flow where the profit fell by -17% overall.
The FY 2016 EPS is about $0.15.
Assuming no growth, and a discounted rate of 10%, the intrinsic value of CDG is $1.52.
But what if we have a baseline growth of 3% after this?
We take it that CDG after a 17% fall in profit, enjoy a normal 3%/yr growth for 19 years, with the terminal growth rate to be 0%. The intrinsic value we get is $1.895.
Reverse Discounted Cash Flow
So I decide to take the first case of 0%/yr growth and see what is the discount rate CDG is currently trading at.
This is similar to doing the XIRR for CDG.
CDG now trades at around $2.04. So we try to make the intrinsic value to be $2.04 by changing the discounted rate.
The discounted rate is 7.5%.
We look at this as the interest rate of holding this volatile bond called CDG over the long run. I think its rather fair. If we reach a discount rate of 10% we got some value.
While they are different animals, you can compare how does this XIRR of 7.5% look versus some recurring cash flow business such as REITs (learn about them here):
There might be better investments around, with less of a baggage.
Of course this is filled with so much assumptions:
- is it only going to be a 17% fall in profit?
- in the future shouldn’t there be some inflationary growth of 3%?
All these affect the valuation. That is why its not always a straight forward decision.
Can the share price return to $2.50? What kind of Growth Rate are We Expecting?
Suppose that after this discounted cash flow analysis and reverse discounted cash flow/XIRR, we sort of think that the fair value discount rate, or required rate of return for the risk we are taking is 7.5%.
This can be subjective, depending on how you and I differ in seeing how risky or less risky CDG is.
But let us assume we agree, and its 7.5%.
If we want CDG to be at $2.50 so that we can break even, what kind of profile are we expecting?
If we fixed the discount rate at 7.5%, and the growth for 19 years to be 3%/yr, the intrinsic value is $2.60.
From 2004 to 2016, the Earnings per share of CDG grew from $0.10 to $0.15. The annualized growth rate is 3.1% during this period. It is not impossible.
Price Earnings / Earnings Yield
So let us take a look at 13 years of CDG Earnings Yield:
I listed out the earnings per share and the free cash flow (which is based on operating cash flow without working capital). They are rather similar. The free cash flow for CDG in general have been slightly weaker than its earnings.
I listed out for each year, the share price that is 1 year later in March. That is usually the end of the financial work year where the financial results come out. For example, in 2015 Mar we will get the full year results of FY2014.
We can then compute the earnings yield. If we invert the earnings yield we get the price earnings.
CDG’s earnings yield have been rather high. Over the 13 years it average around 6.22%.
If we take 2004 to 2010, the average is 6.55%. In the crisis (GFC) it was 7.23%.
It is only in recent years that we see some yield compression to an average of 5%. During this period the EPS went up 50%.
So where are we? Assuming a -17% growth in EPS of $0.15 to $0.125, at a share price of $2.00, the earnings yield is 6.25%.
That is about fair.
What could change this CDG Value Model?
Well a lot of things let me try to summarize them:
- The situation is not as bad as we made out: higher intrinsic value
- Automation and self driving cars reduces cost and bring synergistic business to Vicom, engineering services: higher intrinsic value
- Australia, UK and China business in the past, have been buffered by a strong Singapore Taxi. Now that situation has changed: could be lower
- Currency movement: could be higher and lower
Nothing much is left to say at this point. I think at $2.04 its a rather fair price to pay.
I tried to use 3 ways of valuing it and the numbers look quite close (because the assumptions are quite close haha)
The devil is always in the details. How differently do you see each business segment headed? That will affect the intrinsic value of CDG.
At one point the data shows the situation to be not too bad.
And this is because CDG have the public transport and testing segment that is unaffected by this.
Still, I feel i build in adequate buffer in my assumptions.
The likely XIRR if we want to even buffer in more negativity is 6.5%.
The growth rate will be important because if we can achieve the old 3%/yr growth rate, we have something there. However, if we look through that 13 year history, its been one where the Singapore public transport division have been suffering, Singapore taxi being very durable, and various growth from Australia, China and UK.
For that 3% to happen, you need the region to grow well, and for CDG to increase its overseas market share.
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